LONDON (Reuters) – China’s $16 trillion bond market is the proverbial elephant in the investment room. But it is becoming too important to ignore, even for the most risk averse Western investors.
A large A+ rated sovereign market offering 3% returns, with minimal volatility? This is looking increasingly alluring for European pension funds swimming in sub-zero bond yields as aging populations stretch their finances.
For some, the benefits are starting to outweigh the political risks, and they are increasing allocations to China, or considering doing so, according to Reuters interviews with half a dozen companies that advise and manage the money. pension funds.
“Not all of our clients invest in the Chinese bond market, but they are all interested in it,” said Sandor Steverink, head of treasury at APG, which manages a third of the assets of the $1.5 trillion Dutch pension. euros ($1.8 trillion). industry.
Dutch 10-year bond yields are languishing at around -0.4%, meaning losses for any investor who holds them to maturity, a picture mirrored across Europe.
Such interest in the funds is a boon for Beijing, which is seeking to internationalize its financial markets and attract big foreign investors as its once mighty trade surpluses shrink. The European pension sector alone is worth $4 trillion.
The Chinese debt market is the second largest in the world after the United States. Yet while foreigners own a third of the US Treasury market, they own only 9.7% of China’s sovereign debt, according to government data.
Western pension funds constitute a tiny cohort of foreign investors in the yuan bond markets, but their presence is growing.
Of the $9.5 trillion in assets under management of corporate and public pension funds globally, 0.26% was held in Chinese bonds in the third quarter of 2020, compared to 0.04% in 2015, according to the institutional asset manager data shared with financial data provider eVestment.
Beijing’s drive to attract foreign capital has taken a hit lately as tensions with the United States have led to the ejection of several Chinese companies from US stock indexes and restrictions on US government pension funds. investing in China. There have also been payment defaults by public companies.
Investors also cite potential pitfalls such as less market transparency and liquidity, with some Japanese investors protesting the inclusion of China in the FTSE Russell World Government Bond Index.
In addition, some say the country still needs to go further in opening up its markets and fear that if capital controls, which made it difficult to repatriate profits, were relaxed, they could also be tightened.
China’s relatively successful handling of the COVID-19 crisis and improving economic outlook, however, boosted confidence.
APG manages around 100 million euros in a local China bond strategy launched just over a year ago. Steverink acknowledged that political risks gave clients “cold feet”, but predicted that would change as more cash was absorbed by debt.
“You have to explain if you are investing in China. You don’t need to explain if you’re not investing. That’s how it is at the moment,” he said.
“In the decades to come, it will be the other way around.”
(GRAPHIC: Growing interest – )
2020: A ROTATING YEAR
Pension funds themselves are notoriously secretive about their investment allocation trends, and more than two dozen mostly Europeans contacted by Reuters declined to comment on this.
However, their fund managers, and some central banks that track investment flows, can provide a window.
China has only stepped up its efforts to open bond markets over the past decade, so foreign investment is starting from a low base. While a rise in interest in broader investments is not a new phenomenon, pension funds – the largest and most cautious players – are now starting to follow suit.
Investors polled by Reuters said 2020 had been a pivotal year, with bond yields in more developed countries plummeting into negative territory following massive monetary stimulus, combined with the easing of restrictions on foreign investment by China.
Insight Investments plans to set up a Chinese bond fund on behalf of British pension funds, Sabrina Jacobs, a fixed-income investment specialist at the $1 trillion asset manager, told Reuters.
She declined to give details to protect her clients’ anonymity, but said her company, which is part of the BNY Mellon Group, had also been asked by other UK and European pension funds to explore investments in Chinese debt.
Jacobs said China meets many of the criteria retirement investors have when investing overseas — besides size and credit ratings, the yuan is less volatile than other emerging currencies.
Essentially, this means that daily swings that can destroy returns are less common; in fact, the yuan’s volatility is lower than that of some G10 currencies like the Australian dollar.
Jacobs also said Chinese markets were moving less in tandem with their global peers.
“While you have a very strong correlation between, say, (German) Bunds and Treasuries, Chinese government bonds are only 15-20% correlated with other bond markets, the largest in the world. world. So it’s also an attractive diversifier.
Insight currently holds about $400 million of Chinese debt in its emerging and global government bond funds.
Some other investors who allocate funds on behalf of European pension fund clients, including Pictet Asset Management and Willis Towers Watson, have also said they are seeing increased interest in Chinese bonds in the pension sector.
(GRAPHIC: Give me more – )
“MUCH FURTHER TO GO”
Pictet, with assets of $600 billion, does not break down flows by investor type, but said inflows to its China bond fund rose from $144 million to $770 million in 2020.
Shaniel Ramjee, part of Pictet’s multi-asset team, is convinced that Chinese debt is no longer a niche asset for large institutions like pension funds, but said the trend is not. only at its beginnings.
“We haven’t seen these dedicated allocations in large quantities yet, so there’s a lot to do,” he added.
Dutch pension funds held 22.4 billion euros in overall investments in China in the third quarter of 2019, mostly in equities, with only 300 million euros in bonds, the Dutch central bank said. This is an increase from the 200 million euro bond in 2017.
The latest available data from the German central bank shows that German funds, including pension funds, invested a total of 2.5 billion euros in Chinese bonds in November 2020 alone, an increase of 62 % compared to the same month a year earlier.
Sweden’s AP2, a national pension fund and a rare example of one that publishes its allocation to China, has had a stable 1% allocation to Chinese government bonds since 2017. It manages around $43 billion in assets .
“LOOK HARD AT CHINA”
China, for its part, needs foreign pension funds because its shift to a consumer-driven economy has reduced its trade surpluses.
Pension money also has a special cachet, due to its size – retirement savings in the 22 major economies currently exceed $45 trillion – and its long-term “sticky” nature.
All of this has motivated China to ease access to its markets, allowing its bonds to join the high-level debt benchmarks compiled by FTSE Russell and Bloomberg/Barclays.
China’s interbank bond market regulator did not respond to requests for comment on foreign pension funds’ holdings of Chinese bonds.
Data from the Central China Depository & Clearing Co (CCDC), shared with Reuters, shows nearly 200 foreign funds had invested in Chinese bonds by the end of September through the China Interbank Bond Market (CIBM), 42% above levels of the previous year. The CCDC does not compile specific data on pension fund flows.
“Pension funds are saying they are now looking at China as an alternative,” said Robin Marshall, director of bond market research at FTSE Russell. “They wouldn’t have looked at it a few years ago.”
(GRAPHIC: Eyeing foreign shores – )
(GRAPHIC: The rush to China – )
($1 = 0.7375 pounds; $1 = 0.8245 euros)
(Corrects title, first and seventh paragraphs to clarify that $16 trillion refers to the entire bond market; paragraph 38 refers to the interbank bond market regulator, not the central bank)
Reporting by Dhara Ranasinghe and Saikat Chatterjee; Additional reporting by Toby Sterling in AMSTERDAM; Maiya Keidan in TORONTO, Andrew Galbraith in SHANGHAI and Karin Strohecker in LONDON; Editing by Sujata Rao and Pravin Char